June 27, 2017

Supreme Court Ruling on Lien Stripping

Bankruptcy protection has long been a lifesaver to underwater homeownersDespite the uptick in the housing market, millions of Americans owe more on their first and second mortgages than their homes are worth. When mortgage balances exceed the value of the home, the home is said to be “underwater.”

Sometimes the value of the home is sufficient to cover the balance of the first mortgage but not the second. The recent Supreme Court ruling on underwater second mortgages (discussed below) has limited the options available to homeowners for dealing with the property.

Dealing with an underwater home can be emotionally draining and you probably wouldn’t be reading this post if you didn’t wonder whether there was a legal strategy for dealing with it.

That is why I developed this free guide for Underwater Homeowners. The guide has additional information besides that which I have included in this post. Simply click this button to download the guide. No registration required

Three options for an underwater second mortgage

1. Get caught up on the second mortgage through Chapter 13 bankruptcy plan payments. If the second mortgage is either fully secured or partially secured by the value of the home, the arrearages can be caught up through plan payments, and the time for payment can be greatly extended; thus the arrearage payments are greatly reduced.

Chapter 13 cases typically involve proposing a plan to pay back creditors over sixty monthly payments (five years). A debtor can propose a plan to pay what is owed on the date of the bankruptcy filing in sixty monthly installments. At the same time, the debtor must make each current mortgage payment.

For example, if a Chapter 13 case is filed on October 1, 2011, and as of that date, the borrower is past due on a total of $12,000.00 in second mortgage payments, then the debtor can, through a Chapter 13 bankruptcy case, pay the $12,000.00 back over sixty months, but must at the same time pay each and every month all mortgage payments (first and second). Thus, in October, the debtor must pay his or her October 2011 first and second mortgage payment PLUS the Chapter 13 payment, a portion of which goes to paying the pre-petition second mortgage arrearage. This goes on for sixty months (the life of the Chapter 13 case).

2. Surrender the property and discharge the debt that is secured by it.  Sometimes, borrowers either simply cannot afford to pay second mortgage arrearages in a Chapter 13 case (see above) while at the same time remaining current on their mortgages, or decide not to make those payments because the debt exceeds the value of the property (it is “underwater”). These situations often cause a borrower to decide to give up (surrender) the property in a bankruptcy case and discharge the mortgage debts.

Depending on the borrower’s overall financial situation, the borrower may qualify for Chapter 7, discharging the debt and making no payments to the mortgage lender —or, be limited to a Chapter 13, discharging the debt and paying a fraction of what’s owed to the mortgage lender (the payment depends on the debtor’s individual financial circumstances).

The mortgage lenders will eventually foreclose on the surrendered property, and their recovery is limited to (a) the proceeds realized from the foreclosure sale and (b) any payment through the Chapter 13 plan. Because the property is being surrendered as part of the bankruptcy case, the mortgage debts are treated as unsecured (because the house goes through foreclosure) and are paid the same amount as credit cards, medical bills, and other unsecured debt, according to what the plan proposes that unsecured creditors be paid (generally less than 10 cents on the dollar, but the plan payment depends entirely on each borrower’s financial situation).

3. Strip the second mortgage through an adversary proceeding in the Chapter 13 case.   This is a complex subject, and requires three conditions be met:

  • First, there must be a first and second mortgage on the home.  A home equity line of credit (“HELOC”) is one form of second mortgage.
  • Second, the value of the home must be such that there is no equity to secure the second mortgage.
  • Third, if the homeowner did not have to pay the second mortgage payment, he or she would be able to afford the home.

If these three elements are present the homeowner may file a Chapter 13 bankruptcy reorganization and propose a plan that strips the second mortgage.  Stripping means that the second mortgage is removed as a mortgage lien on the home, and the second mortgage lien debt becomes a general unsecured debt with the others that can be paid pennies on the dollar for the term of the Chapter 13 case.

Enter Bank of America v. Caulkett

The Supreme Court ruled in favor of the banks, once again. Chapter 13 lien stripping is unaffected by this rulingThe United States Supreme Court has just entered a ruling in Bank of America v. Caulkett that holds that a second mortgage on the primary residence of a debtor that is totally underwater cannot be stripped off (taken off the home) in a Chapter 7 case. The argument for stripping is that since the value of the property is not sufficient to cover even a part of the second mortgage debt, stripping does not hurt the second mortgage creditor since there is no equity to secure the debt.

The Supreme Court said no. The mortgage is sacrosanct and cannot be affected.

At present as the law now stands, a totally underwater second mortgage can be stripped in a Chapter 13 case. However, this issue has yet to be considered by the Supreme Court. In view of the Caulkett decision, there is strong feeling that if and when the Supreme Court considers lien stripping in a Chapter 13 case, it will extend the Caulkett ruling to Chapter 13 cases.

Lien stripping requires an experienced bankruptcy attorney‘s counsel and advice. I invite you to call my office and schedule a bankruptcy counseling session to help you determine the right strategy for your particular case.

Meanwhile, this FREE Guide for Dealing with Troubled Real Estate will give you more to consider. Simply click this button to download the guide. No registration required